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Interest rates on certificates of deposit (CDs) have been on the rise for several years. That's been good news for investors, but high yields on CDs are expected to end in 2024. That might nudge you to revisit your investment strategy. Here are some important things to keep in mind this year when it comes to CDs.
What Happened to CDs in 2023
CD rates jumped up significantly in 2023, with annual percentage yields (APYs) reaching well over 5%. The federal funds rate, a benchmark interest rate set by the Federal Reserve, directly impacts CD yields. It's an important factor as financial institutions determine interest rates on credit cards, personal loans, mortgages and other financial products. It also influences yields on savings accounts, money market accounts and CDs. When the federal funds rate increases, CD yields tend to do the same—and vice versa.
Interest rates hit record lows during the pandemic, but have been on an upward swing since 2022. The federal funds rate increased four times in 2023, finishing the year with a target range of 5.25% to 5.50%. Inflation has played a big role here. The Federal Reserve typically raises rates in an attempt to cool inflation. The idea is that higher borrowing costs will rein in spending from both consumers and businesses. That, in turn, can help reduce demand and keep inflation in check.
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What It Meant for Investors
Let's say you put $10,000 into a 12-month CD with a 5.5% APY. When the CD term ends, your account will have earned $550 in interest—assuming you didn't take an early withdrawal. That's essentially free money.
What's Projected to Happen to CD Rates in 2024
The Federal Reserve is expected to start cutting its benchmark interest rate in 2024, though Fed Chair Jerome Powell has suggested that rates could still go up if that helps the Federal Reserve reach its target inflation rate. As of December 2023, the central bank signaled that three cuts are coming in 2024—with more to follow in 2025 and 2026. If the federal funds rate indeed goes down, it's safe to assume that CD yields will likely do the same. That could influence your investment strategy. Lower APYs mean that your money won't earn quite as much as it did before.
What It Means for Investors
Let's go back to the idea of investing $10,000 in a 12-month CD. If the federal funds rate drops, and CD yields follow suit, returns will be less robust than they were in 2023. As an example, let's say the Federal Reserve's target range declines 1.5 percentage points by the end of 2024—and CD rates drop to 4%. That would shave $150 off your earnings.
Should You Buy CDs in 2024?
CDs are considered very stable investments. Most banks provide Federal Deposit Insurance Corp. (FDIC) insurance for up to $250,000 per depositor, per insured bank for each account ownership category. Credit unions provide similar protection, making it highly unlikely that you'd lose money with a CD (assuming you don't make an early withdrawal). If you have extra money to invest and are looking for a safe option, a CD could be a good choice in 2024—though you might want to buy now to take advantage of higher yields before interest rates go down.
If interest rates decline, and CD yields do the same, you might consider other investment options. The stock market has produced average annual returns of around 10% for the last century, higher than CD yields. But individual stock investing carries more risk. Exchange-traded funds (ETFs) and mutual funds can provide a safer way to invest in stocks.
The Bottom Line
CDs are low-risk investments that are especially attractive when interest rates are on the rise. Rates are expected to start dropping in 2024, but CDs may still have a place in your investment portfolio. Your age, risk tolerance and financial goals can help you decide if they're right for you.
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